BANI WALID, Libya, Jan 24 (Reuters) - Libya's
ramshackle government lost control of a former stronghold of
Muammar Gaddafi on Tuesday after local people staged an armed
uprising, posing the gravest challenge yet to the country's new
rulers.

Elders in Bani Walid, where militias loyal to the ruling
National Transitional Council (NTC) were driven out in a
gunbattle a day earlier, said they were appointing their own
local government and rejected any interference from the
authorities in the capital Tripoli.

The town's revolt will heighten doubts in the West about the
NTC government's ability to instil law and order crucial to
rebuilding oil exports, to disarm tribal militias and guard
Libyan borders in a region where al Qaeda is active.

Local elders denied reports that they were loyal to Gaddafi,
who was captured and killed in October after weeks on the run,
and Reuters reporters in Bani Walid saw no signs of the
Gaddafi-era green flags which witnesses earlier said had been
hoisted over the town.

But the collapse of NTC authority in the town, one of the
most die-hard bastions of pro-Gaddafi sentiment during Libya's
nine-month civil war last year, will compound the problems
besetting a government that in the past week has been staggering
from one crisis to another.

The uprising in Bani Walid could not come at a worse time
for the National Transitional Council government. In the past
week its chief has had his office overrun by protesters angry at
the slow pace of reform and the second most senior official has
quit, citing what he described as an "atmosphere of hatred."

Reuters reporters who entered Bani Walid on Tuesday morning
saw a few of the black, green and red flags of last year's
anti-Gaddafi rebellion but there was no sign of any central
government presence.

About 200 elders who gathered in a mosque decided to abolish
an NTC-appointed military council for the town and appoint their
own local council, in direct defiance of the authority of the
government in Tripoli.

"If (NTC chief Mustafa) Abdel Jalil is going to force anyone
on us, we won't accept that by any means," one of the elders,
Ali Zargoun, told Reuters at the mosque.

"BROTHERS IN REVOLUTION"

Accounts from Bani Walid, a town about 200 km (120 miles)
from Tripoli, late on Monday described armed Gaddafi supporters
attacking the barracks of the pro-government militia in the town
and then forcing them to retreat.

A fighter with the routed pro-government militia told
Reuters the loyalists were flying "brand new green flags" from
the centre of town. The flags were symbols of Gaddafi's
maverick, 42-year dictatorship.

But elders on Tuesday disputed that account.

"In the Libyan revolution, we have all become brothers. We
will not be an obstacle to progress," said another elder, Miftah
Jubarra. "Regarding allegations of pro-Gaddafi elements in Bani
Walid, this is not true. This is the media. You will go around
the city and find no green flags or pictures of Gaddafi."

Bani Walid, base of the powerful Warfallah tribe, was one of
the last towns to surrender to the anti-Gaddafi rebellion last
year.

A Libyan air official said war planes were being mobilised
to fly to Bani Walid. But it was not immediately clear what the
government in Tripoli could do. It has yet to demonstrate that
it has an effective fighting force under its command and Bani
Walid, protected behind a deep valley, is difficult to attack.

EMBATTLED GOVERNMENT

During Libya's nine-month war, anti-Gaddafi NTC rebels tried
to take Bani Walid but did not progress much beyond the
outskirts of the town. It later emerged that Saif al-Islam, one
of Muammar Gaddafi's sons who was captured in the Sahara desert
in November, had been using Bani Walid as a base.

Soon before the end of the conflict, with Gaddafi's defeat
unavoidable, local tribal elders negotiated an agreement under
which forces loyal to the NTC were able to enter the town
without a fight.

Relations have been uneasy since then and there have been
occasional flare-ups of violence.

A local resident, who did not want to be identified, said
Monday's violence began when members of the May 28 militia,
affiliated to the NTC, arrested some former Gaddafi loyalists.
That prompted other supporters of the former leader to attack
the militia's garrison. "They massacred men at the doors of the
militia headquarters," said the resident.

FRAGILE GRIP ON POWER

The NTC still has the backing of the NATO powers who, with
their diplomatic pressure and bombing campaign, helped push out
Gaddafi and install the new government.

NTC authorities pledged to unify the tribally-divided
country, reconstruct its once mighty oil industry that made
Libya a major exporter in OPEC, and hold democratic elections.

But questions are now being raised inside some Western
governments about the NTC's ability to govern Libya effectively
and secure its frontiers against al Qaeda, arms traffickers and
illegal migrants trying to get into Europe.

The NTC tumbled into its worst crisis since the end of the
civil war at the weekend when a crowd of protesters in the
eastern city of Benghazi stormed the council's local
headquarters when NTC chief Mustafa Abdel Jalil was inside.

The protesters, who supported the revolt against Gaddafi,
were angry that more progress had not been made to restore basic
public services. They also said many of the NTC's members were
tarnished by having served in Gaddafi's administration.

Abdel Hafiz Ghoga, deputy head of the NTC and target of some
of the protests, said he was resigning. Abdel Jalil warned that
the protests could drag the country into a "bottomless pit."